Panic on the flight deck

Ismail Erturk, Julie Froud, John Law, Ismail Erturk, Julie Froud, John Law,

Adam Leaver, Mick Moran, Karel Williams

ESRC Centre for Research on Socio-Cultural Change

cresc.ac.uk

Disaster movie?

panic on the flight deck

• If the Eurozone crisis is a disaster movie, what’s the title?

• It is a disaster movie: there is no mainstream policy alternative to

fiscal austerity which everybody (including S&P + McKinsey) sees is

“self defeating” undermines growth and debt reduction “self defeating” undermines growth and debt reduction

• Panic on the flight deck = our title because the German captain +

the European first officers are quarrelling about the control

settings, the course, what to do next:

E.g. size of EFSF, ECB shift towards aggressive monetary policy

replacement of elected prime ministers in Greece and Italy,

ructions in Brussels and a Franco/Brit slanging match about who is

weaker

Passengers?

braced for the crash

• Captain has announce turbulence but cabin crew and passengers

fear the worst ie suspect our flight officers don’t know what they

are doing and can’t prevent a crash?

• In business class: financial elites and journalists are proclaiming

crisis e.g. El Erian or FT on “capitalism in crisis”crisis e.g. El Erian or FT on “capitalism in crisis”

• In economy class: the masses don’t trust the pilots e.g. in UK only

19% of Brits in 2009 think banks are well run (90% in 1983) =

“probably the biggest change in public attitudes ever recorded by

the British Social Attitudes series”

• Hostile minority wants to storm the flight deck : Occupy Wall St pro

‘the 99%’ and the populist right e.g. Northern League and Vlaams

Belang

Why is finance uncontrollable?

• Why does elite panic and mass hostility not lead to effective control

of banking and finance?

• Lecture in three sections analysing obstacles to control of finance,

each beginning with a vignette:

1. Deep stall: how finance is technically intractable because of 1. Deep stall: how finance is technically intractable because of

balance sheet interconnections and high velocity circulation

2. The arrogance of ignorance: the limits of the econocrats +

expertise (in regulation and central banking)

3. Democratic disconnects: how the political classes (national and

EU) multiply problems as ‘Gouldite’ politics replace mass parties

• Let’s start with deep stall on another flight deck on a BAC 1-11

prototype in 1963

Obstacle 1

deep stall and the difficulty of

controlling finance controlling finance

Deep stall?

a BAC 1-11 test flight

• Prototype test flight of October 22nd 1963; routine airworthiness

test via induced stalls (vary angle and centre of gravity) recovery =

nose down via stick forward /elevators down and add thrust; since

Bleriot in 1908 Bleriot in 1908

• Fifth stall test of the day went wrong: didn’t pull out although the

pilot Mike Lithgow did everything correctly; the plane fell 16,000

feet, bellied onto the ground with little forward motion

• The accident report diagnosed what we now call “deep stall” =

“recovery was impossible” because of aircraft design e.g. the 1-11

was a T-tailed rear engine jet aircraft = the turbulent air flow from

the stalled wing and engine nacelles blanketed the tail elevator

control surface

Undesigned finance:

balance sheets and rehypothecation

• Why Eurozone crisis not amenable to finance ministry and central

bank management via standard policies

• Undesigned consequences of shareholder value and bricolage in

the markets = web of financial interconnects and flows ex

unregulated private bank lending and market credit creationunregulated private bank lending and market credit creation

• Key interconnects:

a. ex bank balance sheets = a complex pattern of interdependence

and mutually assured destruction through illiquidity and

insolvency across national boundaries when things go wrong

b. ex rehypothecation (i.e. lender’s reuse of pledged collateral to

fund the lender’s further borrowing) = liquidity crisis in the

markets whenever the velocity of circulation of funds falters

• Cross border claims = hugely complex and unknown ex billions in

OTC derivatives; but we can illustrate problem using BIS data on

bank lending

• Aggregate bank lending by country:

a. credit dependency i.e. liabils of domestic banks, public sector and

Cross border claims/

bank lending interconnects

a. credit dependency i.e. liabils of domestic banks, public sector and

non-bank priv. sector to banks in other E’zone countries and UK

b. credit exposure i.e. domestically owned banks foreign claims

• Very different ranking from that of imprudent sovereigns (e.g. Italy

and Greece); high scores for (a) small countries: Ireland, Belgium,

Portugal; (b) bank liabilities 4 or 5 times GDP: UK, NL etc.

• Bilateral claims are transmission mechanisms ex sovereign or bank

troubles; domino effect if banks in any one large country call in

their foreign claims or renege on their liabilities

Domestically owned banks consolidated foreign claims (cross-border+local) -2011 Q2 % of GDP

Total

Austria Belgium France Germany Greece Ireland Italy Netherlands Portugal Spain UK claims ($m)

Austria 0.69% 3.17% 15.65% 0.88% 0.70% 6.46% 4.45% 0.38% 2.10% 5.29% 150,057

Belgium 0.56% 13.30% 3.59% 0.37% 5.44% 5.13% 5.28% 0.75% 0.00% 7.66% 196,931

France 0.9% 9.0% 10.8% 2.2% 1.2% 16.2% 5.2% 1.0% 5.9% 11.0% 1,626,507

Germany 2.7% 1.1% 6.8% 0.7% 3.4% 4.9% 5.2% 1.1% 5.4% 15.6% 1,539,246Germany 2.7% 1.1% 6.8% 0.7% 3.4% 4.9% 5.2% 1.1% 5.4% 15.6% 1,539,246

Greece 0.04% 0.11% 0.61% 2.27% 0.16% 0.17% 1.35% 0.01% 0.12% 3.96% 26,867

Ireland 1.47% 2.15% 7.10% 29.75% 0.40% 5.81% 2.95% 1.04% 7.09% 73.87% 272,399

Italy 5.4% 0.2% 2.5% 13.3% 0.2% 0.7% 1.3% 0.2% 1.5% 2.3% 565,100

Netherlands 1.18% 15.39% 13.22% 25.69% 0.56% 2.22% 6.67% 0.86% 9.93% 14.68% 705,831

Portugal 0.15% 0.20% 3.23% 1.46% 4.42% 2.59% 1.33% 4.55% 11.57% 2.64% 73,655

Spain 0.4% 0.3% 2.3% 4.2% 0.1% 0.7% 2.8% 1.5% 6.3% 30.3% 688,527

UK 0.3% 0.8% 13.6% 8.4% 0.6% 6.3% 3.3% 6.0% 1.1% 4.5% 1,010,567

Circulation of collateral:

rehypothecation

• Circulation of good quality collateral is central to the funding of the

financial system

• Liquidity problems ex (a) limits of collateral creation ex a smaller

MBS market and zero rates of interest plus (b) slowing of long

chain, high speed rehypothecation circuitschain, high speed rehypothecation circuits

i. asset managers lend long-term securities to collateral desks in the

shadow banking sector and

ii. the same securities are used serially as collateral in a number of

trades; increasing leverage on equity/good quality collateral

• What if circulation slows? Estimated $5.8 trillion of balance sheet

items in banks are backed by this kind of collateral reuse;

difficulties of selling sovereign government debt ex absence of

buyers with funds as well as quality of what is sold

Dec 2011 /Jan 2012

at a Serresian moment?

• Michel Serres on transition from (a) orderly ‘turbo’ movement e.g.

circular vortex to (b) disorderly ‘turba’ a “streaming chaos” of paths

and layers

• Loss of momentum is a threat e.g. as the spinning top slows, the

gyroscopic effect fails to hold the top on its axis; as the aircraft wing gyroscopic effect fails to hold the top on its axis; as the aircraft wing

slows to stall speed, lift fails as the attached air flow breaks away

and drag increases

• The threat is of deep stall: sovereign default via interconnects

creates turbulence so the elevators won’t work; illiquidity already

requires surreal ECB intervention e.g. lent €489.2 billion in 24 hours

on 21st December to fearful European banks (which also have huge

short term deposits with ECB)

Obstacle 2:

The arrogance of ignorance: The arrogance of ignorance:

the limits of econocacy

Knowing what to do?

Pre-2008 complacence

• Eg Bernanke’s Nov 2002 encomium on Milton Friedman’s 90th

birthday; a Federal Reserve Board member reviews Friedman and

Schwarz (1963) on how post ‘29 Fed policy error of monetary

contraction and letting banks fail turned recession into depression:

“Let me end my talk by abusing slightly my status as an official

representative of the Federal Reserve. I would like to say to Milton

and Anna: regarding the Great Depression. You’re right, we did it.

We’re very sorry. But thanks to you, we won’t do it again”

• Technocrats with economics PhDs in central banking believed they

knew better/would avoid mistakes/could assert control = pre-

crisis complacence + post crisis TARP + Quantitative Easing =

framing of bank reform as an expert/ technical issue

Central bank led capitalism?

• Hence post-2010 creation of central bank led capitalism ; as

jammed or contractionary fiscal policy is counteracted by ultra

loose monetary policy and ballooning central bank balance sheets

• From pre-crisis hubristic complacence to post-crisis hubristic

intervention with Quantitative Easing in US and UK printing money intervention with Quantitative Easing in US and UK printing money

by buying securities from banks. UK by Oct 2011 planned £275

billion and 0.5% interest = cheap feedstock for financial market

carry trades and doubtful trickle down

• ECB is less heroic because Euro politicians and technocrats are

divided; technocrats are all mainstream economics trained but

divided (a) the structural reformers in a transatlantic field and (b)

the national champions grounded in diverse national attitudes

Structural reformers:

Lucas Papademos or Mario Monti

• Formed within a particular trans-Atlantic field with three defining

peculiarities:

a. Main stream economics PhD in a prestige US University; “give me

an undergraduate at 21 and I will give you the man”an undergraduate at 21 and I will give you the man”

b. Position of responsibility in a major EU institution where loyalty is

performed (P = VP ECB; M = EU commissioner)

c. Relation to big finance as adviser or customer (Goldman Sachs for

P and M ) performs sympathy for the sector

• Result = not repetiive behaviour expertise and a kind of Aspergers

of the imagination as Monti backs flexibilised labour markets,

utility privatisation and state asset sales

National Champions

Juergen Stark vs. Andy Haldane

• Champions formed in national fields e.g. Andy Haldane, B of E

Financial Stability Director= undergrad at Sheffield, Masters at

Warwick, lifer at Bank of England since 1989

• National differences e.g. Juergen Stark resigned in Sept 2011 in

protest over ECB bond purchases (Die Welt interview, 20 Dec) c.f. protest over ECB bond purchases (Die Welt interview, 20 Dec) c.f.

Haldane extended critique of SV banking in his Wincott response to

Vickers (e.g. capital ratios of up to 20%, no tax breaks on debt, end

shareholder monopoly of government, target ROA not ROE)

• UK as home of radical econocrats challenging cross party support

for Vickers ring fencing e.g. Armstrong (NIESR, Oct. 2011) pro

“deeper and more fundamental reforms” because UK cannot bear

risks ex “one of the biggest financial sectors in the world”

Technocrats and politics?

• Structural reformers meet politics as mass resistance via “fight the

cuts”; need the strikes and demos to become ineffectual coalitions

of losers (i.e. public sector workers and service consumers)

• Radicals like Haldane do high politics without allies in civil society

e.g. never mentioned in the British general election of 2010 and has e.g. never mentioned in the British general election of 2010 and has

never met Occupy LSX/St Pauls; an expert on safer banking and no

position on broader policy issues (e.g. party financing)

• Econocracy = a professionalization of expertise (standard back

ground in main stream economics) which does not abolish dissent

but narrows identity and sphere of operation c.f. Haldane as the

darling of the intelligentsia c.f. Keynes and Beveridge moved

between civil service, advising parties, independent research and

journalism

Obstacle 3:

Democratic disconnects as politics

multiplies problems

Conditions of progress?

the post war settlement

• Politics is not an input output machine but effective reform

depends on alignment or connection between constituencies and

institutions e.g. post 1945 settlement:

� social technologies make problems amenable ex technocrats like

Keynes and BeveridgeKeynes and Beveridge

� mass parties (liberal or social democratic) turn technologies into

programmatic policies with parliamentary majorities

� the civil society impulse for change depends on interconects via

institutional overlap and personnel (e.g. party and Trade Unions)

But transmission now difficult because of a series of democratic

disconnects twixt parties , civil society ( and the technocrats)

The mass party,

national politics and the EU project

• Crucial development = the hollowing out of the mass party/the

key mobilising institution right across the EU and most radically in

the UK where 2/3rds of the members are gone e.g. van Biezen data

• Result = a permanent deficit of democracy even as mass franchise • Result = a permanent deficit of democracy even as mass franchise

produces crowd pleasing populism (by political elites within the

frame of hollowed out parties at national level)

• EU becomes the sphere of posturing national politicians and

haggling governments. Adds its own dynamic because the single

market and the Eurozone was a project of elites, alliance of

technocrats in Brussels and Franco-German political elites

Switzerland

Denmark

Netherlands

Germany

% Decline

% Change in party membership size in selected European countries:

1980-2009

(van Biezen et al. 2009)

0 10 20 30 40 50 60 70

United Kingdom

Norway

France

Sweden

Ireland

Switzerland

Change in party membership size in selected European countries:

1980-2009

(van Biezen et al. 2009)

Biezen, Mair and Poguntke. 2009. ‘Going going ….gone: Party Membership in the 21st century’ van Biezen, I., Mair, P.

and T. Poguntke. Paper presented at the ECPR Jt Sessions, Lisbon

The triumph of Gouldite politics

e.g. Cameron’s Brussels veto

• “Parties” are metropolitan cliques whose leaders make narrow

calculations of national political advantage ex

1. What unrepresentative activists and parliamentary party want:

Cameron “I couldn’t get it through my Parliament even if I signed

the treaty” (Daily Mail, 11 December 2011)the treaty” (Daily Mail, 11 December 2011)

2. Engagement with the mass electorate via the Philip Gould use of

polls/focus groups to (a) target swing voters and segments of

electorate and (b) work on the contradictions and inconsistencies

in popular attitudes

E.g. the Brussels veto which did not stop anything but did poll well

e.g. in Populus poll, 56% think Cameron was diminishing British

influence in Europe but 57% think Cameron was right to use the veto

and 44% think it will protect the City of London

EU as a house built on sand

• EU is built on three foundational failures

• Deficit of mass democracy: failure to engage national

populations, low rates of electoral turn out and disastrous

referenda

• Bureaucratic miscalculation e.g. extension of the single market • Bureaucratic miscalculation e.g. extension of the single market

philosophy to financial deregulation under the EU Second Banking

Directive of 1993 and then a consultative system dominated by the

industry

• Intra institutional shift of power from the active Commission of

the Delors period from 1985-1994; response to crisis after 2009

shaped by a European Council of heads of state (dominated by

German-French axis) and the Eurogroup (i.e. head of the ECB +

Ezone finance ministers ) within the Council of Ministers.

Dec 2011/Jan 2012

Merkel and ECB’s pyrrhic victories

• Merkel and ECB get their way: the Council is now a game between

the big member states; EU agenda on priorities and possibilities

(EFSF etc.) is publicly set at ‘Merkozy’ summits before other states

support; independent ECB’s agenda aligns broadly with German

government e.g. pre-2008 on price stabilitygovernment e.g. pre-2008 on price stability

• If we have more of their victories we shall all be undone: (a)

incoherently resisting bank failure and sovereign default while

varying position on hair cuts for bond holders e.g. Anglo Irish Bank

vs Greek sovereign debt (b) dishing out the pain for South

Europeans by endorsing punitive interest rates on bail outs and

publicly insisting that Spanish and Italian bailouts should be

dependent on structural reforms

Implications:

and so? and so?

Implications of our analysis:

technical

1. We are in grave danger: if or when things go wrong, European

finance will probably go into deep stall as turbulence undermines

control

2. We do know where to go: if finance is uncontrollable we need to

construct a smaller, simpler finance system = utility banking with

controls on property lending

3. A few key players like Haldane see the need for radical

reform, but right now there is no econocratic consensus for radical

intervention to simplify finance.

1. Things will have to get worse before they can get better: Glass-

Steagall after 50% of US Banks had failed or ben taken over

2. Democratic disconnects limit our political capacity to process the

finance problem; mainstream political classes (in UK, US and EU)

Implications of our analysis:

political

finance problem; mainstream political classes (in UK, US and EU)

disabled by their electoral calculations and their identification with

big finance

3. As long as civil society is not organised or programmatic on

finance, the impetus for change will most likely come from

opportunist populism in the main stream and the rise of radical

right